Financial Leverage, Operating

Leverage , Combined Leverage

Prangeted by
CHANDAN SINGH
Contend
Meaning
Financial leverage
Operating leverage
Combine leverage
Risk of leverage
 Leverage

 Leverage has been defined as "the action of a

lever is , and mechanical advantage gained by
it”.
 Leverage is the means which a business firm
can increase the profits. The force will be
applied on debt, the benefit of this reflected in
the form of higher returns to equity
shareholders.
 Master table to calculate the leverage
Particulars Amount(Rs)
Sales xxxx
less: variable cost xxx
Contribution XXX
Less: Fixed cost xxx
Earning before Interest and tax xxx
Less: interest xxx
Earning before tax xxx
Less: tax xxx
Earning after tax xxx
Less: Preference dividends xxx
Earning available for equity share holder xxx
 Financial leverage

• Financial leverage is a tool with which a financial manager can

maximize the returns to the equity shareholders.
• Financial leverage signifies the relationship between the earning
power on equity capital and rate interest on borrowed capital.
• Financial leverage helps the finance manager to select an
appropriate mix of capital structure. Capital is required for the
purpose of meeting both long-term & short-term financial
requirement of a business unit. This could be raised through
long term as well as short term sources, namely, Equity shares,
debentures, preference shares, public deposits.
Formulas


 Operation leverage

 The operation leverage has a bearing on fixed costs. There is

a tendency of the profits to change, if the firm employs
more of fixed cost in its production process, greater will be
the operating cost irrespective of the size in its production.
The operating leverage will be at a low degree when fixed
costs are less in the production process. Operating leverage
show the ability of a firm to use fixed operating cost to
increase the effect of change in sales on its operating profits.
Formulas
 Combined leverage

 This leverage shows the relationship between a

change in sale & the corresponding variation in
taxable income. If the management feels that a
certain percentage change in sale would result in
percentage change to taxable income they would like
to know the level or degree of change & hence they
adopt this leverage.
Formulas
 Represents maximum use of leverage
 Degree of Combined or Total Leverage
(DCL or DTL) = %age  in EPS / %age 
in Sales
 a  in Sales  a larger  in EPS
 Short-cut formula:
DCL or DTL = DOL x DFL
 Leverage Means Risk

 Leverage is a double-edged sword

 It magnifies profits as well as losses
 An aggressive or highly leveraged firm has high fixed costs
(and a relatively high break-even point)
 A conservative or non-leveraged firm has low fixed costs
(and a relatively low break-even point)
 Many Japanese firms tend to be highly leveraged
Thank you